YEAR RISK-FREE INTEREST RATE 1.80% 4.00% YIELD TO MATURITY OF 10-YEA...

1-year risk-free interest rate 1.80% 4.00%

Yield to maturity of 10-year government bond 4.30% 7.50%

Duration of 10-year government bond 7.50 8.00

Country beta 0.50

Current spot exchange rate 2.00 SCF = 1 TRF

MacDougal’s forecast spot exchange rate in one year 1.97 SCF = 1 TRF

MacDougal determines that adding bonds from Tauravia to his existing government bond

portfolio will increase the portfolio’s yield and decrease its duration. However, he is concerned

about the effect of changes in exchange rates on the returns for these bonds. He assumes the

forward exchange rates of both currencies reflect interest rate parity.

A. Calculate the percentage of MacDougal’s domestic government portfolio that should be

allocated to 10-year Tauravia government bonds to decrease the portfolio’s duration to